What is a 403b?
A 403b plan is a retirement plan for certain public school individuals, employees of tax-exempt organizations, and ministers. Individual 403b accounts are set up by employees and managed by eligible employees.
While not as prominent as the better-known 401k, the 403b retirement framework is often used by schools systems, churches, hospitals and may other types of organizations.
The structure of the 403b is as follows.
An individual account within the 403b typically takes the form of a Tax Sheltered Annuity. This is an annuity contract offered by an insurance company. In exchange for a premium, which can be paid in a lump sum or a series of payments. The insurance company agrees to make fixed or variable payments beginning at a future date. This can be either for a specific term or for the rest of your life.
Like a pension, your contributions and your contract’s earnings from investments can consider building up your retirement income stream.
A 403b can also be structured as a custodial account that can invest in mutual funds.
Some 403b plans which are specific to churches can take the form of an account that invests in either mutual funds or annuity contracts.
You can’t contribute directly to your 403b plan. What they do instead is per your salary-reduction agreement they withhold a predetermined amount from your paycheck. This is known as an “elective deferral”. These elective deferrals are exempt from income tax, although you are still responsible for Medicare and Social Security tax on these contributions.
Plan earnings are also exempt from income tax until the participant withdraws them. This is one of the big benefits of the 403b plan and the tax-deferred annuity structure.
One thing to keep in mind is that some plans don’t allow for after-tax elective deferrals. In these cases, the deferral amounts aren’t deductible on your tax returns. Of course.
On top of elective deferrals, your employer can contribute directly to your plan via “non-elective contributions”. Current regulations allow your account to be funded through a combination of elective deferrals and employer contributions.
So how much can I contribute to my 403b?